Yields on long-dated Japanese bonds hit their highest level for 18 months after Japan's finance minister appeared to quash market hopes of government intervention in the market.
Kiichi Miyazawa said he was not concerned about recent rises in yields, been driven by concerns about chronic over-supply in the bond market.
Analysts said Mr Miyazawa's remarks dispelled speculation that the government could move to cap yields, and prompted some investors to dump substantial holdings of bonds on to the market.
Michael Derks of Nomura said: "There's potential for JGB [Japanese bond] yields to rise further ahead of the fiscal year end."
The surge in yields had a knock-on effect in the currency markets, where the dollar fell by almost 2 per cent against the yen, its biggest one- day drop since mid-November.
Traders speculated that investors would move money into Japan to take advantage of the higher bond yields, and the dollar fell to 112.77 yen, down from 114.96 in late trade on Monday.
Technical factors relating to the Japanese fiscal year-end on 31 March and mounting US-Japan trade tensions also undermined the dollar.
Eisuke Sakakibara, a leading official in Japan's finance ministry known as "Mr Yen" because of the impact of his remarks on the Japanese currency, highlighted the trade issues at a conference in Tokyo.
He warned that trade relations with the US, already strained, could deteriorate further over the course of the year. His comments fanned speculation that the Japanese authorities could let the yen rise against the dollar to placate the US.
One analyst said: "The feeling is that the US will want a weaker dollar, although no one has suggested that in the US administration."